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FOR ANY lawmakers considering new regulations on the Internet – and I know
there are a lot of you out there – please consider the results of regulation
in a parallel universe: the telephone industry.

In stark contrast to the wide-open, fast-paced world of the computer, the
telephone sector has had a long history of stagnation and scarcity, driven
by heavy regulation. Deregulation has brought spectacularly lower
long-distance rates – but much of the sector remains regulated. And the
latest battle in Congress is a perfect example of what’s wrong with
regulated markets.

In free markets, companies try to improve their competitive position by
enhancing their products, refining their marketing, or negotiating better
deals with suppliers and customers. In the telephone industry, companies go
to Washington for a regulatory re-write. It’s a nice system for the
companies involved. There’s no business mistake that can’t be fixed with a
do-over called by the government.

Right now, the local Bell telephone companies say that they’re paying too
much to competitors – specifically, to companies, which, in the jargon of
the business, are called Competitive Local Exchange Carriers, or “CLECs”
(pronounced “see-lex”). The CLECs get paid by the Bells when they complete
calls that start on the Bell network. These payments are called “reciprocal
compensation.”

The Bells also get reciprocal comp. In fact, it was their idea in the first
place. When CLECs were created under the 1996 Telecom Act, the Bells figured
that they would be receiving lots of money for completing calls originated
by the newcomers. So they lobbied hard to get laws in place. The argument
was that, since telephone calls have a beginning point and an ending point,
companies at either end of the line should get paid.

That seemed to make sense.

But, as competition unfolded, many CLECs – such as Pac West, Intermedia and
Focal Communications–aggressively entered a new arena. Instead of just
signing up residential customers and businesses, they were quick to see the
potential in serving ISPs (Internet Service Providers), which, of course,
connect folks to the Internet. The Bells, on the other hand, largely ignored
the ISP business.

Since ISPs generate big volume, the CLECs found themselves in the happy
position of completing tons of calls that were originated on Bell networks.
Thus, the Bells owed them lots of money under the reciprocal comp provisions
the Bells themselves had urged Congress to support.

The Bells cried foul! This wasn’t the way things were supposed to work out.
So, instead of trying to compete on service or price – or simply by buying
out some of the better CLECs – the Bells did what they usually do: they
appealed to politicians for a solution. Now, they want Congress to eliminate
reciprocal compensation.

In the meantime, the CLECs claim, the Bells have simply stopped paying their
bills to them. This puts the CLECs in a precarious position, since they aren’t flush with cash.

But think of what would happen if reciprocal comp were eliminated on ISP
calls: clearly, the CLECs would demand more money in service fees from the
ISPs, which would pass the costs on to their customers. Cheap Internet
connections would suddenly become ancient history.

So how could Congress even think of changing the reciprocal comp law? Well,
the Bells have a lot going for them. First of all, the telephone regulations
are so complex that few customers have the time and interest to figure out
who’s doing what to whom. In other words, this is not a grassroots issue –
though it ought to be.

As a result, the winner in this battle is going to be the lobbyist with the
most clout. The Bells don’t have to win the intellectual argument or
demonstrate with a peer-reviewed economic analysis that consumers are better
off under the plan. They just have to build bridges to the key votes and
find a few hardcore supporters willing to fight.

One big question is why Congress is deciding the reciprocal comp issue in
the first place. The matter is already part of the Telecom Act of 1996,
which is overseen by the Federal Communications Commission and dozens of
state public utility commissions. It has been subjected to numerous
lawsuits. If Congress rewrites the law, we’ll have to start the whole
process over again.

In this fight over reciprocal comp, the Bells are backing a bill called H.R.
4445 in the House and another called S. 2902 in the Senate – both of which
could end up as amendments to a larger bill. With a compressed schedule
before lawmakers break to campaign, an amendment (especially one that the
public and the press don’t notice) is the likely route.

The legislation should not pass. If it does, it will inevitably mean higher
costs for consumers to connect to the Internet – and will reinforce the Old
Economy system of deciding what’s best, not in the marketplace, but in
Washington.